Friday, October 2, 2009

Editor's note: There is no editor. Much like Qaddafi's translator at the UN, the editor went mad halfway through and began screaming "I can't take it anymore!". Therefore, venturing forward into this stream of consciousness is a decision not to be taken lightly, continue at your own peril.If your still determined to continue, just click here, move the pop-up aside, and read.

Imagine walking into a casino where you're always a winner. Every game is rigged in your favour, every dealer is not only your friend, but accomplice, and the pit bosses are all in your pocket. At first, you can't imagine your luck, so you pump a few quarters into the slots. With each pull your stake grows. Over at the blackjack table you make a couple of small bets and your cards keep adding to 21. Emboldened by your early success you walk over to the craps tables where you start to push your luck as the dice are hot. A crowd grows, the collective excitement of the screams, shouts and cheers pushes you on as if in a dream. Other players are drawn in, with piles of chips going onto the 'pass' line and the 'no pass' bar on each roll as everyone is getting into the action, betting with and against you - how do they both keep paying off? You must have been born lucky as you've wandered into no ordinary casino. Somehow you've won the lottery and wound up a big banker in today's America, a world onto it's own where thanks to the system you can't lose. All well and good for those fortunate few, but really, can it go on forever?

We're a year removed from what was nearly the biggest global financial meltdown ever, yet looking around it's hard to see any tangible proof that we're in a better position than we were then; I'd argue that things have, in fact, gotten worse. The heart of the problem lies in the Panglossian vision of the financial world that still reigns supreme despite the abyss that we stared into not so long ago. Instead of viewing the markets as a casino with risks and pitfalls that need to be controlled, we live in the best of all possible worlds where the efficient market theory asserts that financial markets always get asset prices right given the available information. Therefore the best thing corporate chieftains can do, not just for themselves but for the sake of the economy, is to maximize their stock prices. Problem is, this efficient market is far too heavily influenced by a few rent seekers (some would call them parasites, sucking the blood out of the organism while giving nothing in return, others, simply banksters). A feedback loop wherein increased wealth leads to increased influence leading to increased wealth... Eventually those in power become completely beholden to these few. Together, they have managed to dupe the entire world into believing in the market's omniscience. Witness the knee jerk reaction by large swaths of the population, many of whom are dirt poor, without health insurance, to any suggestion of trying to improve the lot of millions, as it would involve obstructing the 'free' market. In other words, finance economists believed that we should put the capital development of the nation in the hands of what Keynes had called a “casino”. What keeps the rest of us content is the illusion that we, too, will eventually be able to game the system, so long as the government doesn't interfere.Yet interfering is exactly what the government has done over the past year, with little or no questioning of why we're supporting a broken system. To seriously question a system that promotes short term profits and corruption remains blasphemous. Fact is, the capitalism we have is evil and it's threatening to devour itself along with the world. When a financial crisis hits most nations, investors run for the exits, the IMF swoops in, sweeps away the old banking regime and imposes usurious trading rules and financial regulation on the country. We've now seen what happens when a similar crisis hits the USA. A couple of scapegoats are allowed to fail (Lehman Brothers, Bear Stearns, Merrill Lynch...) while the friends of the ruling elite are saved by pumping tax payer money into them; trillions of dollars of wealth transferred from tax payers to wealthy bankers. Of course it was these bankers who made the ridiculous gambles seeking short term profits which allowed them to pay themselves huge salaries and bonuses. When the giant Ponzi scheme collapsed, no one was found responsible, worse yet, to question and regulate is seen as somehow "communist", and those guilty parties are allowed to continue on their merry way.

So, how did we get here? Historically, banking has been a risky industry having seen its share of spectacular crashes. Until the Great Depression, major crises struck about every 15 to 20 years – in 1792, 1797, 1819, 1837, 1857, 1873, 1893, 1907 and 1929-33. Then the crises stopped. The last two led directly to the creation of the Federal Reserve and the New Deal. A magical machine to manufacture money out of thin air along with financial regulation such as federal deposit insurance, the passage of the Glass-Steagall Act and the separation of commercial and investment banking created a stable environment without hindering growth which was also broad based as we saw either stable or falling income inequality. Unfortunately, the seeds of moral hazard were also planted. As depositors and investors no longer had to worry about the soundness of the banks, they would be attracted to riskier institutions and higher rates of return without the fear of downside risk, causing money to flow to weak banks rather than strong. Said one opponent in 1933, “A reputation for high character [in banking] would be cheapened and recklessness would be encouraged.” Fortunately, the authors of Glass-Steagall (and the follow-on Banking Act of 1935) prepared for this threat, authorizing not only public deposit insurance but also meaningful bank regulation, designed to ensure the safety and soundness of insured banks.

All was well for almost 50 years, creating wealth but also breeding arrogance. We began to forget the lessons of the past as memories of the Depression faded and economists fell back in love with the idealized vision of an economy in which rational individuals interact in perfect markets. We moved away from Keynes' vision of financial markets as a casino and replaced it with Eugene Fama's efficient market theory in which financial markets price assets at precisely their intrinsic worth given all publicly available information. John Meynard Keynes didn't replace capitalism as many critics feared at the time, he simply fixed it. Unfortunately, the last half a century saw a revival of the neoclassical Adam Smith style belief in 'trust the market'. Your Milton Friedmans and Schumpeters of the world convinced us to start loosening the grip on the banksters. The hubristic faith in the market omniscience was embodied by Alan Greenspan, a man who believed the market could regulate itself on everything from fraud to derivative trading. At the same time the influence the banksters could exert on public policy was growing. Finance's success in the 80's coincided with the rise of the era of Washington lobbyists which lubricated the revolving door between Wall Street and government. Just looking at the myriad of connections between Goldman Sachs and political power is mind boggling. Henry Paulson, Dubya's last Treasury secretary and present secretary is a former Goldman CEO, Robert Rubin, Clinton's last Treasury secretary spent 26 years at Goldman before becoming chairman at Citigroup; John Thain, he of the $87,000 area rug for his office, spent time at Goldman before driving Merrill Lynch into the arms of Bank of America, Robert Steel, Mark Patterson, Ed Liddy, the heads of the Canadian and Italian central banks, the World Bank, the New York stock exchange, the last two heads of the Federal Reserve Bank of New York ... you get the picture. Somehow Wall Street was able to launch a successful takeover bid of the Beltway and could now dictate its terms. Regulation needed to be eliminated in order to allow finance to continue to grow; to achieve this, in the 10-year period beginning in 1998, financial companies spent $1.7 billion on federal campaign contributions and another $3.4 billion on lobbyists. In 1997 and 1998, the years leading up to the passage of Phil Gramm's fateful act that gutted Glass-Steagall, the banking, brokerage and insurance industries spent $350 million on political contributions and lobbying. Gramm alone — then the chairman of the Senate Banking Committee — collected $2.6 million in only five years.

Culturally, America and her wannabes, the rest of the world, changed too. (Begin using old man voice) Back in the day, it was understood that you had to work hard to be successful. Today, that ethos has been lost as everyone and their uncle search for the next get rich scheme. Materialism has gone beyond acceptance and become the standard to which we strive. Both the public and private spheres have made their contributions as governments sponsor lotteries, gambling which disproportionately hurts the poor while we are subjected to a 24/7 media which promotes an excessive lifestyle. The effects are plain to see; between 1950 and 1980 personal consumption was remarkably stable in the US, amounting to about 62 percent of GDP. In the next three decades, it shot upward, reaching 70 percent of GDP in 2008. During this period, debt exploded. In 1960, Americans’ personal debt amounted to about 55 percent of national income; by 2007, this figure had surged to 133 percent. By 2019 the federal government's debt will be 83% of GDP with yearly interest payments of $803 billion. By the end of the Bush presidency, one that saw over $1.3 trillion in tax cuts which mainly benefited the top 1% of earners, the poverty rate had risen to 13.2% while median household income had fallen to $50,303 from $51,295 ten years earlier, adjusted for inflation. Consumerism became more than just keeping up with the Jones', it became patriotic even while debt levels were driving risk to unsustainable levels. Yet, somehow through all this, the teabaggers and their ilk have saved their anger for a Socialist/Nazi/Communist/Alien plot to destroy the nation by trying to give health care to the masses. Immodesty has become as ubiquitous as advertising as self indulgence, self-love, self-advertisement, are not only accepted but celebrated. It would seem that Ayn Rand has truly won the day.

Worse yet, the warning signs were all there. Since the age of deregulation we've seen Savings & Loan meltdown, the LTCM debacle, the Asian Crisis, yet we keep marching to the same drum beat. Accounting scandals, market manipulation and an internet bubble showed us how easy it is to be lured to the dark side, yet we keep dancing to the same song. Maybe it's because we've been hypnotized by the rhythm for so long we no longer have the power to stop the music. Finance and banking exist for one simple purpose, to efficiently allocate capital. So, what happens when all the capital, both human and monetary, is all tied up in finance? Profits of the financial industry as a percentage of total global profits were a mere 5% when Reagan sat in office in the early eighties; by the time of the crisis, that number had reached 30%. Wiz kids coming out of school no longer dream of working for NASA or becoming a doctor, lawyer or engineer; the holy grail is now finance, to come up with a Gaussian copula function toevaluate or even eliminate risk. And why not, they're just behaving in a logical, capitalistic way, as pay in the financial sector has risen dramatically. From 1948 to 1982, average compensation ranged between 99 percent and 108 percent of the average for all domestic private industries. From 1983, it shot upward, reaching 181 percent in 2007. Works intended as cautionary tales of excess such as The Bonfire of the Vanities, Barbarians at the Gate and Wall Street, have served only to increase Wall Street's mystique. 10 years ago if you'd have been walking down the main drag of my home in Poznan, Poland, Swiety Marcin, you would've been able to stop at a variety of shops. Today, you can drop by a branch of some bank and walk by empty shops squeezed out by the higher rents brought on by their well-heeled neighbours. Speak to the majority of the brightest minds entering higher education and you'll learn that most dream of a career on Wall Street. And why wouldn't they? Even after the crash, the 30,000 employees of Goldman Sachs earn an average salary of $700,000. Eight major American and European banks will pay the 141,000 employees in their investment banking units $77 billion in 2011, about $543,000 per worker.

While the financial crisis may have been good for the planet, it wiped out a lot of wealth; US households alone saw their net worth decline by $13 trillion. There was a time when bankers had to pay a price for their mistakes; if you ran a bank, and the bank couldn’t repay depositors or other creditors, those people had the right to confiscate all your personal assets and income until you repaid. Even the idea of 'double liability' in which stockholders were responsible for twice the original value of their shares in a bank existed until the age of the Fed in the US. Let's see a few examples of what happens today:

AIG. Patient Zero of the global economic meltdown, Joseph Cassano, head of AIGFP (400 employee London-based AIG Financial Product division). After bundling the crappiest mortgages they could find and slapping AAA ratings on them, banks needed someone to insure them. Enter Joseph and the Amazing Technicolor Credit Default Swaps, CDS. AIGFP's returns went from $737 million in 1999 to $3.2 billion in 2005. Over the past seven years, the subsidiary's 400 employees were paid a total of $3.5 billion; Cassano himself pocketed at least $280 million in compensation. Of course we know how this story ends, housing prices start falling, AIG's AAA credit rating begins to slide, triggering collateral calls and by February 2008, AIG is posting an $11.5 billion loss. What happens to Joseph? Burned at the stake? No, the company not only allowed Cassano to keep $34 million in bonuses, it kept him on as a consultant for $1 million a month. A short time later, it came out that AIG was planning to pay some $90 million in deferred compensation to former executives, and to accelerate the payout of $277 million in bonuses to others. When Congress balked, AIG canceled the $90 million in payments. Then, in January 2009 AIG decided to pay out another $450 million in bonuses. And to whom? To the 400 or so employees in Cassano's old unit, AIGFP, which is due to go out of business shortly! Yes, that's right, an average of $1.1 million in taxpayer-backed money apiece.

Two of the other main culprits in the financial meltdown, Fannie May and Freddie Mac, have actually gotten bigger, and therefore more dangerous.

Merrill Lynch CEO Stanley O'Neal, a man who acknowledged his mistake in overexposing his firm to subprime and thus causing its downfall walked away from the company with a severance package worth $162 million. Executives of the company had their $3.6 billion in bonus payments moved forward to December last year before the firm was taken over by Bank of America for fear of having them cancelled. Well, at least someone's trying to do something about it.

Five of the biggest US banks - Goldman, JPMorgan, Wells Fargo, Citigroup and Bank of America - posted second-quarter profits totaling $13 billion. That's more than double what they made in the second quarter of 2008 and nearly two-thirds as much as the $20.7 billion they earned in the second quarter of 2007, when the economy was strong. The main argument for the bank bailouts was that they were "too big to fail", yet the net result is banks that are now even bigger. The bailout enabled mergers and acquisitions have left those banks still standing in an even more dominating position. And what happens when 4 banks (Bank of America, Wells Fargo, JP Morgan Chase and Citi) issue one of every two mortgages and about two of every three credit cards? The top four banks raised fees related to deposits by an average of 8 percent in the last quarter.

And how about Goldman Sachs? The bank paid out an astonishing $4.7 billion in bonuses and compensation in the first three months of this year, an 18 percent increase over the first quarter of 2008. It also raised $5 billion by issuing new shares almost immediately after releasing its first quarter results. Taken together, the numbers show that Goldman essentially borrowed a $5 billion salary payout for its executives in the middle of the global economic crisis it helped cause, using half baked accounting to reel in investors, just months after receiving billions in a taxpayer bailout. And what did Goldman give back to the people of the United States in 2008? Fourteen million dollars, an effective tax rate of one percent. The bank paid out $10 billion in compensation and benefits that same year and made a profit of more than $2 billion, yet it paid the Treasury less than a third of what it forked over to CEO Lloyd Blankfein, who made $42.9 million last year.

The reality is that the worldwide economic meltdown and the bailout that followed were together a kind of revolution, a coup d'état. They cemented and formalized a political trend that has been snowballing for decades: the gradual takeover of the government by a small class of connected insiders, who used money to control elections, buy influence and systematically weaken financial regulations. Previously, a dozen or so big banks formed the top tier. Now Goldman Sachs and JPMorgan Chase are clearly the strongest, with Morgan Stanley struggling to compete. Bank of America and Citigroup are the weakest big banks, heavily reliant on government guarantees to survive. The extensive government support that began after Lehman collapsed will lead investors to assume that governments will always prevent major banks from collapsing. The Greenspan put has been replaced by the Bernanke put (a put is effectively a promise to buy an asset at a fixed price if you are unable to sell it to someone else at a higher price – this is a way to lock-in profits or limit losses on investments) so investors will continue to lend money to the financial industry on easy terms. In turn, financial institutions will use that cheap money to make risky loans and trades. The banks will keep the profits when their bets pay off, while taxpayers will swallow the losses when the bets go bad and threaten the system. Economists call the phenomenon moral hazard. Bankers have a different term: I.B.G. The phrase implies that by the time a deal goes sour, “I’ll be gone,” after I get my huge bonus.

Even when someone in a position of power raises the issue of whether parts of our financial system have become dysfunctional, s/he faces heavy criticism from all quarters. Witness the reaction faced by the UK’s chief financial regulator, Adair Turner, when he suggested just that, and called for greater capital requirements at banks and pondered how it would be possible for regulators to preserve the valuable parts of our financial system while regulating to limit the harmful parts. For some reason it is a given that the rich deserve an advantage of say, 30 milliseconds. Or that it's a good thing that financial gurus are giving up bundling mortgages in favour of old and dying people's life insurance policies. Or that instead of betting on you to default on those mortgages, now there just making bets on nations defaulting on their sovereign debts, in index form, and not just Argentina. Wait, even better, remember all the slicing and dicing, with the tranches and other voodoo they did to turn those crappy mortgages into AAA securities? Well, apparently, with a little more alchemy and sharper knives, they can be re-rebundled in order to further lower bank capital requirements. Hooray, it's the re-remic!

But what's the problem you may ask. Markets are up, nations are emerging from the recession, the financial industry is back to inventing new ways to make profits, all will be well in the world once again, maybe we do live in the best of all possible worlds. Wrong. Someone has to pay when the bubbles burst, and who has been paying the bill upfront for the taxpayer to this point? - China. And just as investment firms such as Goldman Sachs had insurers like AIG protecting their exposed behinds while they placed their bets on various financial derivatives, China is busy trying to hedge their bets on the US economy. After AIG wrote hundreds of billions of dollars of credit insurance and had no money to make good on its promises when the bonds defaulted, the US government was there, but who will be there when the US government can't find someone to buy their debt to pay the bills? So China is covering their bets by putting their money on themselves, with a little help from glittering gold. Realizing the world will not continue to support a fiat currency that can simply multiply itself at will to solve any problem and thereby reduce it's value (simple economics), China seems to be putting all the pieces into place to make themselves the world's store of wealth. Aaah, yes, competition. With nowhere else but US Treasuries to invest until now, the world has been forced to support the bubbles that America has chosen to create. September 28th saw an important volley in the coming financial war as 6 billion yuan worth of government bonds went on sale in Hong Kong. Taken together with the push for increased importance of the International Monetary Fund's Special Drawing Rights and lust for gold, it's clear they're looking for other avenues of investment. Any good investor knows that you have to limit your downside risk, and the financial industry's debt along with the increase it has caused in government debt pose significant systematic risk. While everyone moaned and groaned about the $700 billion TARP bailout, the real cost to the taxpayer is clouded by secretive operations with names no one has heard of such as Term Auction Facility, the Term Securities Lending Facility, the Primary Dealer Credit Facility, the Commercial Paper Funding Facility and a monster called the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility, or how about something called a Money Market Investor Funding Facility, plus three facilities called Maiden Lane I, II and III. No one even knows where the bailout money has gone or how it's being paid, but the bottom line is a potential price tag of $23 trillion, yes trillion with a 't' for the US tax payer to pay for the mistakes of the financial industry and China knows that not even they can finance that. History is replete with examples of financial experts telling us that this time it's different, but if there is one common them to financial crises it is that excessive debt accumulation, whether it be by governnment, banks, corporations or consumers, often poses greater systemic risks than it seems [to do] during a boom.

No ideology can stand alone in the world. That would be a monopoly. Capitalism has stood unchallenged for 20 years now as an unchallenged monopoly (What do we really call China's system these days?). Monopolies are cancerous to the capitalist system. The defeat of its only legitimate rival, communism, has brought about a situation that has slowly killed what capitalist, neo-cons and Reaganites dreamed of creating. Is that irony? Or some kind of meta-level parallel. I don't know, but it's become clear that the monster created by this untethered beast, the financial system, is ever closer to destroying the world that it's trying to control and there's no one trying to stop it. Back in 1907, they say that JP Morgan single handedly saved Wall Street guaranteeing tens of millions of dollars to keep the wheels of finance turning. Today, the people, through their governmental agent, the Fed are guaranteeing trillions due to the latest bubble, and I'm afraid the bubbles have to get bigger each time to keep the party going. Oh no, the G20 meeting might force new regulations onto the industry, not! More likely they would be encouraging instability in order to smooth the way for the FSB (the Financial Stability Board, not the new KGB). Oh no, President Obama is giving a speech to bankers about their responsibility to act prudently, well, what self-respecting banker would bother going to be lectured to? If you wonder why they don't need to listen, just ask yourself whose money put Obama in the White House. Then perhaps you may realize as Voltaire's Candide did, that Dr. Pangloss really is just wearing rose coloured glasses.

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comments:

Superb post... just superb!The sheer enormity of what we face makes for scary reading, and the initial reactions of anger and frustration are, of course, woefully inadequate responses to it. They are, sadly, all we have!

it's become clear that the monster created by this untethered beast, the financial system, is ever closer to destroying the world that it's trying to control and there's no one trying to stop it.

This post has at least made this particular traveller feel a little less alone!

@Jim, it's great to hear that someone actually got through the entire post (you did, didn't you?) When a situation exists where income distribution is more inequitable that anytime since 1929 and we're gifted with the perfect opportunity to do something about it and yet don't, that's scary. The talk today was even scarier out of the UK today, ominous IMF warnings equating debt reduction with NHS funding... yeah, that's the problem!

@Troy, I hear you, it's a sad day when a 'socialist' party figures making it easier to fire people is a good way to deal with a recession. (Crying voice) But my business needs more flexibility to grow, get out of my way evil government and make it easier to destroy people's lives.

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Part-time recluse, part-time rockstar,full-time ranter. Paying the bills teaching English in the wild west of capitalism.
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